Can our oil refinery survive?

When Australian-born Naomi James accepted the role of CEO of Refining NZ in January, she knew it would be a tough job. She didn’t know how tough. No one anticipated Covid-19, quarantine, empty roads, empty skies. Nikki Mandow talked to James towards the end of a long two weeks shut in a hotel with her newly-arrived family, and asked her ‘Can the refinery survive?’

There are many reasons to be thankful as we come to the end of New Zealand lockdown. One is not having to do Jacinda Ardern’s job.

Another is not having to do Naomi James’.

Having accepted the job of chief executive of Refining NZ in January, James took up the role in April, moving with her family from Australia.

Refining NZ's new CEO Naomi James couldn't have anticipated spending two weeks in quarantine in Auckland. Photo: Supplied

For her first two weeks heading New Zealand’s only oil refining company, James worked out of three hotel rooms shared with her husband and three sons aged seven, 12 and 15. She combined being a new CEO with other tasks involved with being in quarantine lockdown in a hotel in a new country with three children in new virtual schools.

At least Jacinda Ardern has a home.

No one is saying leading a country of five million is comparable with leading a company of 400, but both women are navigating unprecedented times.

And unlike New Zealand, which was in pretty good shape when the Covid-19 virus arrived, Refining NZ was already in trouble, with little light on the horizon.

Up close on a sunny day, with the backdrop of the blue waters and green headlands around Northland’s Marsden Point, the oil refinery looks like what you’d get if you crossed Rainbow’s End amusement park with Willy Wonka’s chocolate factory, with the Pompidou Centre in Paris.

The chemical process might be complex, but the model is simple: they take crude oil, process it into petrol, diesel, kerosene, bitumen, and fuel for planes and ships. Then they send it out, either via the pipeline to Auckland (known as the RAP, the Refinery-Auckland Pipeline), or in coastal tankers to destinations elsewhere.

The process also generates CO2 for soft drinks and sulphur for fertilisers.

In an irony that won’t be lost on Naomi James, virtually all the crude oil for the refinery is imported because our home-produced crude isn’t suitable. Instead that is exported for refining.

Source: Refining NZ

The refinery was built in the 1960s using government money, and expanded to the tune of $1.81 billion under Robert Muldoon’s Think Big projects in the 1980s. At the time it was seen as a good thing for the country to have its own refining capabilities. Fuel security.

These days the refinery is privately-owned - a listed company with three major shareholders - petrol retailers Z, BP and Mobil, and several thousand private and corporate ones.

But over the last few years, the business case for a refinery has become more and more shaky. For a start there has been increasing refining capacity around the world, with refineries in the Middle East, China, India, South Korea taking more and more crude oil and turning it into fuel.

The problem for New Zealand is many of these refineries are bigger and newer and can produce fuel cheaper than we can. Some also get support from their governments.

At the same time, Refining NZ has to pay relatively more for its electricity and gas than its competitors overseas, James says. Just recently it’s got so bad that the ‘fee floor’ in the company’s processing agreements (a $140 million minimum amount the refinery gets each year from its customer-shareholders Z, BP and Mobil) no longer covers its cash costs.

And those big shareholder customers aren’t happy with the deal either. Twenty-five-year-old processing agreements tie the petrol companies into putting a certain amount of crude oil through the refinery. But there’s a risk, particularly in a falling market, that they could have got cheaper fuel by simply buying it ready-refined on the global market and avoiding Refining NZ altogether.

At times it must seem to the petrol retailers like they are losing money and propping up the refinery, while at the same time watching the value of their investment diminish as Refining NZ’s share price tanks - a double whammy.

Refining NZ's share price has been largely on a downward path since 2008. Source: NZX

Short-term pain

Everything came to a head when the company announced its financial results for the 2019 year. Its gross refining margin went from an average of US$5.85 per barrel in the first 10 months of 2019 to US$2.62 in November and December. Net profit after tax went from $30 million in 2018 to $4.2 million in 2019.

The share price fell from around $2.30 at the beginning of 2019 to $1.88 at the end of the year.

But if things looked bad then, they were set to get a whole lot worse.

In January this year, the oil price started to drop, making it even harder for Refining NZ to make money. And in March the coronavirus struck and demand dried up too. Apart from a few delivery trucks and the odd essential worker, no one was going anywhere. Fuel demand tanked, which is bad news when you are the company that supplies 85 percent of the country’s jet fuel, 67 percent of its diesel, 58 percent of all petrol, and 100 percent of fuel oil for ships.

Refining NZ’s share price slumped below 70 cents at the end of March and is still trading at less than $1.

Long-term pain

But surely everyone’s in the same boat? Things will pick up.

Not necessarily - the long-term picture for Refining NZ is pretty bleak too. Look at it this way: the company’s sole raison d'être is to make a product we are all trying to work out how to get by without. Oil.

Environmental organisations like the 1point5 Project believe that for New Zealand to deliver on its Paris Agreement goal of limiting the global average temperature increase to 1.5°C about pre-industrial levels, our transport must be largely decarbonised by 2030.

And while so far the Government is far from delivering policies that might make this a reality, if it did suddenly get enthusiastic about meeting its Zero Carbon Act targets, that’s more bad news for Refining NZ.

As Paul WInton, founder of investment capital advisory company Temple and head of the 1point5 Project told Newsroom - and a meeting of the Institute of Finance Professionals - earlier this year:

“If you have to decarbonise road transport, then your refining assets are not worth much. In a scenario where volumes of liquid fuels are seriously challenged over the next decade, I can’t see how the business model of a refinery has a future.”

It’s tough stuff. But Zooming in from her Auckland hotel room last week, bland hotel art on the wall behind her, the new CEO didn’t seem too fazed.

“It’s because of the challenge I’m here,” James says. Her mother came from New Zealand, and she’s spent time here on holiday, but has never lived here; that’s not the reason she’s taking the job.

“I really enjoy those challenging situations where you have structural industry changes occurring, and you have really significant government policy issues. You have long-term customer and market positions, and the need to bring your stakeholders with you, and reset the direction, and contemplate a future world that’s going to be quite different with the transition to greener fuel.”

You must maintain unwavering faith that you can and will prevail in the end, regardless of the difficulties, and at the same time, have the discipline to confront the most brutal facts of your current reality.

What’s her leadership style? She quotes from the classic management book Good to great by Jim Collins about businesses confronting brutal facts.

“Every good-to-great company embraced what we came to call ‘The Stockdale Paradox’,” Collins says on his website. “You must maintain unwavering faith that you can and will prevail in the end, regardless of the difficulties, and at the same time, have the discipline to confront the most brutal facts of your current reality.”

James says she isn’t scared of the brutal facts confronting Refining NZ, and she believes there are opportunities as well as challenges.

“When it’s really difficult, there’s a clarity of communication and a clarity of expectation and you really have to set standards high. It would be much easier to roll over in bed and pull up the covers and hopefully you wake up and things are easier.”

The strategic review

James’ first task is to lead a strategic review of the company, including getting management consultants McKinsey & Company involved. Announced to the stock exchange by Refining NZ chair Simon Allen on April 15, there are four options being considered in the review.

Source: Refining NZ

Options one and two are adapted from the status quo but involve improved financial performance with or without changing the business model.

Option four is the most radical and involves shutting down the refinery and running an import-only operation using the company’s infrastructure assets - the pipeline to Auckland, the storage tanks, wharf facilities and fuel ships.

Some are calling shutting the refinery the “mercy killing” option; putting the plant out of its misery before good money is thrown after bad. Keeping a refinery going and competitive requires continual investment on upgrades and maintenance.

Option three - split the company

In the middle is an option to split the business into two - the refining operations in one company and the infrastructure assets in another.

Source: Refining NZ

The benefit of that option, James says, is that you separate the more risky, commodity-based refinery parts of the business from the more stable infrastructure parts. And that makes it easier and cheaper to raise money to invest in the infrastructure side.

“As we think about growing our infrastructure, we need to be able to access really competitive low cost debt, low cost capital, to be a really efficient and competitive infrastructure operator.”

What sort of infrastructure investment might the company be thinking about? James points to the 2017 Refinery-to-Auckland Pipeline rupture which disrupted flights and led to some petrol stations running out of some fuels. An inquiry identified a number of weaknesses in the oil supply chain, particularly when it comes to jet fuel. The report into the incident called on the petrol companies to make investments to make the fuel supply chain more robust.

“One of the questions for the strategic review is whether there is a broader opportunity for Refining NZ as the independent operator of shared infrastructure to own other assets and to invest to ensure the whole of the supply chain has got the capacity and the resilience it needs.”

Within the current corporate structure, that’s expensive.

“It’s a challenge because in effect we have the capital structure and cost of capital of the overall refinery, which is much higher than for the infrastructure side, reflecting the higher risks involved in that business.”

But the question remains, would it not be simpler just to close the refinery down?

Australian refineries close

Over the last decade or so, oil companies have been shutting down refineries all over Australia. Exxon Mobil closed Port Stanvac in Adelaide in 2009, Shell shut refining operations at Clyde in New South Wales in 2012 and converted the site into an import terminal, Caltex closed its Kurnell refinery in Sydney in 2014, also turning it into a fuel-importing facility; BP announced an end to refining in Brisbane in 2014.

The problem was the same: low margins and too much competition from Asia.

To be fair, Australia still has four operating refineries, although Caltex shut part of its remaining refinery last year as margins slumped. Last month it brought forward maintenance that will shut the rest - for now.

Decommissioning and demolishing Exxon Mobil’s Adelaide refinery also took four years (2010 and 2014) and included getting rid of 340,000 litres of oily water and waste oil and 200,000 litres of “various products and chemicals”.

One thing that could possibly save the refinery is government, and James says discussions with ministers and their ministry teams are a key part of the early stage of the review process.

“We are talking to government about what is the strategic importance of having a refinery in New Zealand. And we are asking about the future transition to greener fuels and whether the assets we have could in the future play a role in the production of things like hydrogen and biofuels.

“There are other issues that are coming up, like [government action on] climate change and what we should assume about future policy under the Emissions Trading Scheme. These are important questions for us to have a view on, and ideally a level of confidence and certainty around future government policy in that space.

"It’s an ongoing discussion."

Refining NZ's planned solar farm, if completed, would be the largest in the country. Photo: Refining NZ.

Late last year, Refining NZ’s previous CEO Mike Fuge announced it was going ahead with a project to build the country’s largest solar electricity plant on its site. The aim was to produce 10 percent of the refinery’s electricity from the 31-hectare farm and shave around $3 million-$4 million from the company’s electricity bill, Fuge said.

Around the same time, November 2019, Refining NZ also submitted to the Ministry of Business, Innovation and Employment a “vision for hydrogen in New Zealand”. The company proposed investing in producing “green” hydrogen for hydrogen-fuelled vehicles and asked for government support.

“The Government has a critical role to make a domestic hydrogen industry a reality,” chief development officer Julian Young wrote in the vision proposal. “Policy frameworks will need to be developed and given the current cost of manufacturing green hydrogen, financial support will be needed to allow for early investment in hydrogen technology.”

Under Naomi James, the solar project is on hold and green hydrogen remains a “vision”.

“Through the strategic review we absolutely want to make sure we’re setting ourselves up for those sorts of opportunities. But equally we’ve got to deal with the competitive reality of today. And those are not opportunities that exist today. There is not a short-term path to what are significant, fundamental market changes in demand that will occur over tens of years, not in the space of the next few years.

“And that, from a refining point of view, is what we need to survive.”

Still, the long-term potential is part of the discussion with government, she says.

“The risk is we take decisions that are necessary in the short term to survive, but we lose permanently out of the New Zealand economy capabilities that will be critical to being able to transition to new types of fuel in the future.

“It’s a challenge and I don’t have an answer for you on that today.”

Yet another gnarly problem for the Government and for Refining NZ is the company’s role as a larg-ish employer in the Northland region.

“With a staff of close to 400, and strong relationships with local contracting companies, Refining NZ is proud of the contribution we make to the local community,” the website says.

In tough times, losing 400 jobs in Northland won’t be easy.

There’s hope. All options are on the table. But all those options are going to involve change.

Where to from here?

Jones says the first phase of the strategic review should be complete in June and then the board will make its decision on the preferred option or options.

Then there will be more work to plan the implementation of that decision.

In the meantime, a week after first talking to Newsroom, James says life in New Zealand is settling down - including getting out of quarantine and into their own home.

“The immediate priority after leaving hotel isolation was a free choice of food for the kids for the first time in two weeks - resulting in multiple Uber Eats deliveries to the house the first night home.”

At last: after six weeks in the job and two weeks in quarantine, Naomi James was able to visit the refinery. Photo: Supplied

James also had the chance to head up to the refinery and meet the management team in person for the first time since starting as CEO six weeks before. She says it’s been hard to initiate such a fundamental strategic review without being able to communicate face-to-face with staff, but she didn’t have to wait long after arriving at the refinery to find out what was on the mind of the people working there.

“A 40+ year veteran in the operations team came up to welcome me and the only question he wanted to ask: ‘Is there still hope?’

"I told him straight, ‘Yes there’s hope. All options are on the table. And there are options here. But all of those options are going to involve change.”

There is no status quo.

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